Developing countries face range of challenges in devising effective tax strategy

• Pages: 209-219

Page 209

Vito Tanzi, Director of the IMF’s Fiscal Affairs Department, and Howell Zee, Chief of the Department’s Tax Coordination Division, met with the IMF Survey to talk about their Working Paper, Tax Policy for Emerging Markets: Developing Countries.

IMF SURVEY: What are the special characteristics and needs of developing countries that set them apart from other countries in terms of tax policy?

TANZI: The most basic characteristic is the level of taxation, which in industrial countries is twice that in developing countries. Thus, the governments of industrial countries can do many things that the governments of developing countries cannot do. When developing countries attempt to do the same things, they get into trouble because they don’t have the resources. A second characteristic is the structure of taxation. In industrial countries, a large proportion of taxes comes from income taxes, especially on individuals. In developing countries, the share of personal income taxes is very small. A third characteristic is the quality of the tax administration, which is much better in industrial countries where the actual, orPage 217 effective, tax system is not very different from the nominal, statutory one. The laws are broadly applied as they are intended to be applied. In developing countries, tax laws are passed, but the application is often very different.

ZEE: The differences are not independent of each other. To a large extent, the differences in the level of sophistication of tax administration in developing countries influence the way these countries raise revenue.

TANZI: Also, industrial country taxes are broadly mass taxes. In developing countries, the number of taxpayers is much smaller, because the distribution of income is much less even and the administration is not as good. So, the focus is on fewer individuals and fewer corporations.

IMF SURVEY: How critical is the level, as opposed to the composition, of taxation?

TANZI: The level is very important for determining what a government can finance. Governments have certain basic needs, such as building roads, providing schools, and hiring soldiers and police. The structure is important for determining the incidence—who pays the taxes, how fair the tax system is, and so on. But the two are, of course, related.

IMF SURVEY: What would you counsel a developing country to do if it wanted to attract different types of investment? What is the role of tax incentives in advancing economic development?

TANZI: This is a hot topic. The general view is that tax incentives are pretty useless and that the best incentives are low tax rates and a broad base. A tax system that is well designed, fairly enforced, and well administered is really the best incentive because investors want certainty; they don’t want too many changes.

Yet, for a variety of reasons, governments in some countries cannot face the idea of leaving allocation to the market. They want to play an active role, and sometimes this active role is an honest role. They truly believe they can influence investment decisions in a certain way. But incentives lend themselves to corruption. They are rarely totally objective. Somebody somewhere in the government has...